ECON40315-WE01-Financial Risk Management Analyses – Economics Assignment Help

Assignment Task

Task 

Financial Risk Management

Question 1:
a. Consider the following stock options trading on the exchange, for an underlying stock with a price of £100:

A trader decided to sell 200 call options with a strike of 100.
(i) How would the trader maintain a delta-gamma hedged portfolio?
(ii) Evaluate the performance of this hedged portfolio for when the stock price drops to £99, the call option 1 price is £9.70, and the call option 2 price is £5.63.

b. Describe the Asset Value Approach used in measuring credit risk migrations of a portfolio.
Illustrate using an example of your choice.

Question 2:
Suppose Sarah Jones is the chief investment officer of a hedge fund specializing in options trading. She is currently back-testing various option trading strategies that will allow her to profit from large fluctuations— either up or down— in a stock’s price. She observes the following pricing information on securities associated with the company FriendsMeet, a new internet start-up hosting a leading online social network:

• FriendsMeet stock: $100
• Option 1: Call option with an exercise price of $100 expiring in one year: $9
• Option 2: Call option with an exercise price of $110 expiring in one year: $6
• Option 3: Put option with an exercise price of $100 expiring in one year: $8
• Option 4: Put option with an exercise price of $90 expiring in one year: $5

a. Using the above information, draw a diagram showing the net profit/loss position at maturity for the straddle strategy. Clearly label on the graph the breakeven points of the position and discuss the payoffs of the strategy.

b. Sarah Jones’ friend proposes the strangle strategy as another low-cost option strategy that could profit from large fluctuations in FriendsMeet’s stock price. Using the above information, draw a diagram showing the net profit/loss position at maturity for this strategy. Clearly label on the graph the breakeven points of the position and discuss the payoffs of the strategy.

c. Discuss the differences between the trading strategies examined in (a) and (b) above.

Question 3:
a. An insurance company has a liability with a present value of £100 million and a duration of 12 years. It wants to invest it in a matching bond portfolio with the same present value. It is contemplating using 3 bonds that have the following characteristics:

Suppose the company wanted the bond portfolio to have the same duration as the liability, and preferred to use just two bonds to do this with. Answer the following four questions:
(i) Which bonds would be the most suitable? Explain your choice.
(ii) What is the nominal value of the bonds that should be bought?
(iii) What would the annual coupon income of the portfolio be?
(iv)Suppose there was a small change in the shape of the yield curve, where the yield on 10- year bond fell by 10 basis points. What will be the change in the value of the hedged liability?

b. Derive mathematically the formula for the duration of a zero coupon bond.

Question 4:
Suppose you hold a portfolio of stocks denominated in a foreign currency. Explain how you would use RiskMetrics mapping procedure to calculate this portfolio’s Value at Risk (VaR) in your domestic currency.

Question 5:
a. In backtesting Value at Risk (VaR), a Risk Analyst produces the following figure for his portfolio:

(i) Discuss the various formulas used in generating the different lines within the figure.
(ii) Analyse the figure and discuss the findings you draw from it. Based on your findings, what would be your recommendation to the Risk Analyst?

b. Outline clearly the steps in implementing bootstrapping in the historical simulation approach used to estimate portfolio Value at Risk (VaR). Compare and contrast with the filtered historical simulation approach.

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